Market's favourite mining stock

At the beginning of 2016, the fate of the miners looked set. Exaggerated concerns that China's economy was grinding to a halt amid a severe supply glut caused commodity prices to crash. However, the mining sector was about to embark on a mammoth rally that would help the FTSE 100 break records.

Surging 255% from its low, Glencore plays a big part in the story and its bull run may still have legs. David Butler, lead mining analyst at broker Barclays, has reinstated coverage of the miner and commodities trader with an 'overweight' rating, named it his top pick for the European mining sector, and slapped a 390p price target on the shares, implying 32% potential upside.

Glencore is a bit different to its mining peers. While it lacks the giant high-grade iron ore resources that Rio Tinto, BHP Billiton and Vale enjoy, it holds competitive positions in copper, coal, nickel and zinc markets. It has a 12.3 billion-tonne copper resource that is graded higher than its peer group, with lower costs and - subsequently - higher profit margin. Its coal business is just as competitive.

The miner has had time to save itself since the end of 2015, when its price/earnings (PE) multiple flashed 676 times for 2017, dividend payments had been scrapped and net debt was expected to reach $37 billion (£30 billion) by the end of 2016.

At the same time, however, the EV/EBITDA multiple flashed an undemanding 8 times and the free cash flow yield reached 8.8% - "supporting the case that valuation metrics can be very misleading in this sector," says Butler.

Management has been hard at work since, deleveraging the balance sheet, while keeping net debt/EBITDA capped at 2 times. By selling $6.3 billion of assets, net debt has slumped to around $10 billion and the company is also trying to pay off $2.6 billion of bonds early to reduce annual redemptions below $3 billion.

After axing its dividend, management has embarked on a more sustainable policy that will see investors receive £1 billion each year, plus 25% of industrial free cash flow (FCF). That equates to an attractive 14p per share in 2017.

"Management's 'never again' balance sheet strategy, the bond redemption programme, the intense scrutiny of the marketing business and the cost-cutting programme at the mine level all mean it is unlikely that we will ever see the tremors of 2015 again when the market questioned the company's status as a going concern," explains Butler.

"We argue that fears over asset quality are unwarranted. We also believe Glencore's commodity exposure and growth potential are well suited to the current macro conditions while the valuation metrics speak for themselves."

Adamant the best response to the downturn was to curtail production, chief executive Ivan Glasenberg pulled 400,000 tonnes of copper cathode from the market, mostly from the Katanga mine, and 500,000 tonnes of zinc. This has helped cut costs for now, and when Glencore ramps up production again, it's should enjoy the highest compound annual growth rate of the big UK-listed diversified miners.

Glencore sceptics are concerned about the marketing division, specifically over the forecasting and deliverance of operating profit, accounting of readily marketable inventories and Letter of Credit accounting. The group's hedging practices may also be a thorn, but Butler is confident that the division should be off the hook from here.

While the direction of commodity prices is a bigger driver of share prices than valuation, Glencore still looks "compelling" to the broker. It's got a 15.1% 2017 FCF yield, growing to 17.7% in 2018, an EV/EBITDA ratio of 5.2 and 4.8 respectively, and the PE has unwound from a three-digit figure to 9.3 for the two years ahead.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.